WASHINGTON – Bye, aggressive, rate-hiking Fed. Hello, cautious, market-friendly Fed.
The Federal Reserve held its key interest rate steady Wednesday and said it will be "patient" as it weighs further hikes, signaling a new wait-and-see approach until it gets a better read on a slowing economy and volatile financial markets.
"The case for raising rates has weakened somewhat," Fed Chairman Jerome Powell said at a news conference.
"The U.S. economy is in a good place," he said, but added there's growing evidence of "crosscurrents," such as slowing growth in China.
The central bank also indicated on Wednesday a greater willingness to keep its roughly $4 trillion portfolio of government bonds elevated to prevent long-term rates from rising if the economy falters. That marks a shift from its prior plan to steadily shrink its balance sheet.
"In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments" to its key interest rate will be necessary to meet its goals of a strong economy and labor market and about 2 percent annual inflation, the Fed said in a statement after a two-day meeting.
The Federal Reserve in Washington (Photo: Brendan Smialowski/AFP/Getty Images)
That contrasts with its mid-December statement, which said the central bank's policymaking committee "judges that some further gradual increases" in the federal funds rate would be warranted.
Stocks surged higher Wednesday afternoon after the Fed statement, which followed strong earnings reports and forecasts from big U.S. companies. The Dow Jones Industrial Average ended the day up 435 points, or 1.8 percent, at 25,014.86.
Fed decisions are watched closely since they have wide implications for markets and the economy. Interest rates on Americans' credit cards, adjustable-rate mortgages, home equity lines of credit and some student loans directly respond to Fed moves.
Powell said Fed policymakers are considering slowing the pace of the portfolio reduction. Economist Andrew Hunter of Capital Economics now believes the Fed will stop shrinking the balance sheet when it reaches $3 trillion to $3.5 trillion early next year, substantially above levels previously expected.
Powell telegraphed the central bank's warier stance in interviews this month, saying repeatedly the Fed will be "patient" and "flexible." But Wednesday's statement marks its first formal pronouncement of that view in a policy document.
It amounts to a swift turnabout for a Fed that just last month raised its benchmark interest rate by a quarter percentage point for the fourth time in 2018 to a range of 2.25 to 2.5 percent and forecast two more hikes this year.
That was a pullback from its prior estimate of three rate increases in 2019 and came amid a slowing U.S. and global economy, a trade war with China that's starting to take a bigger toll on growth and a stock market sell-off. Also, the positive effects of federal tax cuts and spending increases are expected to fade later this year.
But investors rebelled and stocks sank further after the December Fed meeting on the belief that policymakers should have indicated they were pausing in their rate hike campaign in light of the economic headwinds.
Powell and other Fed officials promptly obliged and reversed course, noting in public remarks that a tumbling market hurts consumer and business confidence and spending. Fed fund futures markets now expect no rate hikes this year.
"Additional rate hikes this year may no longer be the base case," Michelle Girard, Chief U.S. economist of NatWest Markets wrote in a note to clients.
What it meansThe Fed is trying to walk a delicate line. In an attempt to calm markets, policymakers are signaling a more tempered view of the economy and a more prudent approach toward rate hikes. At the same time, they don't want to send the message that the economy is weakening significantly, which also would make investors, households and businesses jittery and possibly roil markets anew.
Balance sheetIn October 2017, the Fed began gradually shrinking its $4.5 trillion portfolio of Treasury bonds and mortgage back securities, most of which it purchased during and after the financial crisis to lower long-term interest rates and stimulate the economy. Rather than sell the assets, the Fed is allowing them to run off by no longer reinvesting some of the proceeds as they mature.
The strategy has nudged long-term rates higher.
Last month, Powell suggested a balance sheet reduction was on autopilot, an assertion that helped disrupt markets.
But in a statement Wednesday, the Fed said it's prepared to adjust the balance sheet runoff "in light of economic and financial developments." The Fed could even boost the portfolio if necessary to combat an economic downturn, the statement said. Another reason the Fed plans to maintain a larger balance sheet is that banks need the cash supplied by the Fed purchases to meet higher capital reserves in the wake of the financial crisis, Powell said.
The economyThe Fed took some of the sheen off its outlook, saying the economy has been rising "at a solid rate." Last month, it said "economic activity has been rising at a strong rate."
Most economists still expect solid growth of about 2.5 percent this year but that would be down from an estimated post-recession high of 3 percent in 2018. A report on economic growth in the fourth quarter and all of last year that was scheduled to be released Wednesday morning was delayed because of the 35-day government shutdown.
In fact, the recently-resolved shutdown provided the Fed more reason for caution by delaying the release of key data on the economy, retail sales, business investment, housing and construction, and by dampening the economy's performance in the first quarter.
JobsThe labor market, though, keeps chugging along, giving the Fed reason to believe the economy remains on firm footing despite the hurdles. The Labor Department, which was not shut down, said employers added a booming 312,000 jobs in December and a robust monthly average of 220,000 last year.
The Fed reiterated Wednesday that the "labor market has continued to strengthen."
InflationThe Fed noted that certain bond prices that reflect inflation expectations "have moved lower in recent months."
With inflation muted, Fed officials have said they can wait and see how the economy evolves before raising rates again.
The Fed's preferred measure of annual inflation was 1.8 percent in November and a core reading that strips out volatile food and energy items was 1.9 percent – both below the Fed's 2 percent target. The latest measure for December hasn't yet been released because of the government shutdown.
However, the Labor Department's consumer price index moderated further in December on falling gasoline costs.
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